The Constructive and Destructive Powers of Indebtedness

Countries like Mauritius would be able to get back to business again if our principal markets, which are affected by what goes on in Europe and America, picked up reasonably well again. It all depends on how well the debt markets are put back into good gear

Neither a borrower nor a lender be;

For loan oft loses both itself and friend,

And borrowing dulls the edge of husbandry.

— Polonius to Laertes, his son, in Shakespeare’s ‘Hamlet’

It is an undisputed fact that excessive lending by financial institutions in the West is a principal cause of the global economic downturn during the past five years. Many have been asking that the bankers who crossed the limits, chasing after profits, should be punished. This is not the first time debt is being pilloried for social ills.

Not many generations past in Mauritius, a good number of people would cast blemish on someone who took to borrowing money. If one member of society moved a bit higher up than the rest, when almost everyone was steeped in poverty, those left behind would deride him and ascribe his relative success to being a ‘borrower’. This kind of explanation would be given to pin him down for the frail basis of his ‘so-called’ success. In other words, he was portrayed as someone who was literally ‘broke’, a social stigma from which it was difficult to escape in those days. He would be spoken of as someone who is ‘Kangaal’, i.e., without a penny, dependent, and, hence, worthy of contempt. He would be downgraded to the class of profligates. In some sort of a muted expectation of the worse to come, his fall would be expected sooner or later.

This kind of view might find explanation in the history of the distress inflicted upon borrowers in societies from which the people came. There were in India unscrupulous informal moneylenders who would extricate the last penny from the hands of the poor illiterate peasant but the overall debt incurred would stay put, not coming down by even a single rupee, no matter how much the peasant had paid back in the interval. After spending a whole lifetime repaying the debt, the peasant would at last come to realize that all he has been able to do was to pay solely the ‘interest’ on the loan.

The principal amount might even be inflated in the meantime by creative accounting and all manner of compounding for unpaid interest in a year or two when the crop failed. At the time of his passing away, such a borrower would end up in misery, the little amount of land he initially owned now fully attached into the hands of the moneylender. The debt would therefore be ‘bequeathed’ to the next generation, who might now become the moneylender’s (and his descendants’) bonded labour. Victims of a system of harsh exploitation of the sort saw it as the root cause of enduring poverty.

Malpractices and negative perceptions of debt across societies

Abusive lending practices appear to have prevailed in several societies all over the world.

The practice of ‘usury’, the charging of exorbitant interest rates by lenders, has thus been condemned across the board. In 1290, Jews were expelled from England on the grounds that they would have indulged in usurious practices. The theme runs deep around the character Shylock, a Jew, in Shakespeare’s play ‘The Merchant of Venice’ written around 1596. In other places, families unable to redeem the debt they had raised were reduced to becoming the slaves of those who had lent them money. In some places, borrowers would have to pay in kind, such as by ceding daughters, even during the children’s age of innocence, to the lender who would accept them as wives in exchange for forgiving the debt.

The often traumatic consequences of borrowing on individuals should explain why people in different parts of the world developed a high degree of aversion towards the informal debt systems which prevailed at the time. Debt dramas occur typically when the borrower miscalculates his ability to repay the debt or if he is trapped by an exploitative lender having ulterior motives such as getting hold of his property by engaging into lending to him. Sometimes, both these factors come into play at once.

Indebtedness often ravaged the little wealth some families had managed to acquire in the years after colonization accelerated in Mauritius. In many cases, the title to land – the main asset the migrants used to acquire – was created by means of a ‘bordereaux’, an informal title deed yet to be registered in the name of the owner. The title would thus pass on to the one who was in physical possession of the ‘bordereaux’. Moneylenders who lent money would take up those ‘bordereaux’ as security for loans and advances they would grant to planters. It was then left to them to return this informal title deed to the borrower when repayment was completed.

Unscrupulous moneylenders would, under some pretext or other, keep back the ‘bordereaux’ to themselves even where the debt had been redeemed. This document would help them establish their own title to the lands given as security even though the debt would have been partly or fully repaid or would be repaid by the next crop. It was difficult to stop them from such intent, especially when the land in question held the prospect of appreciating sharply in value in future, much beyond the value of the original debt incurred.

Many borrowers managed to extricate themselves from the clutches of unscrupulous moneylenders but others who were not competent enough to beat the device lost everything they had worked for during a lifetime. Factors such as this would explain the aversion to debt which prevailed in society at the time and the consequent habit of generations of workers to hoard cash they managed to stack away from their meagre incomes in view of a future purchase.

Debt is now the principal engine of economic growth

Those who burnt their fingers, and sometimes even their hands, on an occasion or two, from having had recourse to borrowing developed a dread for it. They became risk-averse and would prefer to carry out all their dealings in cash. Such persons would heed Polonius’ advice to his son that he should refrain from engaging in destructive debt.

Today, no enterprise of some significance and respectable scale can be set up even by a rich person based on his own cash resources. At least, no ambitious and enduring industrial activity can be contemplated in the modern world without raising adequate resources from outside sources. The economic infrastructure has changed completely putting the debt system at the very heart of the modern economy. Markets for products are vaster today and can cover the whole world. Things work out wonderfully if one knows how to employ the modern debt system to good purpose and in good measure.

Just as it is a debt crisis that brought America and Europe into recession as from 2007-08, it is good to recall that it is an unprecedented accumulation of debt that had driven the high economic growth rates for years before this crisis. Thanks to generous hand-outs of credit by financial institutions in a low-interest environment, the concerned economies gathered tremendous – and what then looked as unstoppable — steam. House prices soared sustained by unfaltering demand supported by credit at low interest rates. Simultaneously, financial institutions’ lending for fiscal support, investment, consumption and property soared to levels never seen before.

The other side of the coin showed up in 2007 – the year of the reckoning – and the Lehman crisis of 2008. This pace of credit growth had become unsustainable. Things had got inflated into an enormous debt bubble ready to burst at the least sign of panic. Property prices tumbled sharply when the bubble burst. Most of the properties financed by the preceding credit boom were suddenly worth much less than their mortgage values. The debts could simply not be repaid. Economic recession followed. It hit hard the purse of borrowers. Unemployment started soaring. Enormous amounts of bad debts landed on banking books. Banks’ capital was sharply eroded by the huge amounts of unpaid bad debts given out during their previous overdrive. Past years’ frantic pace of explosive credit growth had dried out their liquidity as well. The debt market abruptly came to a grinding halt. Everybody – governments, enterprises, households — which had over-borrowed went tumbling down along with the financial institutions. And the rich economies all along.

Some delicate engineering to do to get going again

This kind of reversal of booming economic conditions has taken place in the past and things have been set right, though not without undergoing periods of severe pain. Good debt management can restore growth but it could prolong the crisis if mishandled. This is where one needs to pull the levers delicately so as to restore an otherwise useful credit system which has shown that it can sustain worldwide economic growth and deliver people from poverty across the world. The European Central Bank has just embarked on an enterprise to restore the free flow of healthy credit to where it has the most growth effects. The economic recovery will come about if it succeeds. America also appears to be riding out of the storm even though we need to wait awhile for it to set in firmly.

Countries like Mauritius would be able to get back to business again if our principal markets, which are affected by what goes on in Europe and America, picked up reasonably well again. It all depends on how well the debt markets are put back into good gear. Measures of harsh austerity will imperil the system. But a careful cleaning up of the Augean credit stables can restore the badly impaired health of financial institutions in their role as lenders to the economy.

The economic episode which has played out since 2007-08 has displayed how unbridled debt can disrupt the very heart of the modern economic system. It has also shown how vital a role debt now plays in both developed and developing countries. Mismanaging it is responsible for a lot of social injustice and disruptions, true, but it is also a non-negligible contributor to the upward march of economic development. If one nurtures the ambition to become an economic entrepreneur of some importance, it would not be by shying away from it as if it were evil; it would be by mastering its use to good effect.